Shifting Corporate Bond Landscape

The regulatory fallout from the financial crisis continues to be felt across different sectors of the financial markets.  The corporate bond market, where trading and liquidity have historically been facilitated by broker-dealers, has become less liquid as regulations requiring more capital force broker-dealers to carry lower corporate bond inventories on their balance sheets.  Increased capital requirements and higher risk-weightings have made it expensive for firms to hold large amounts of corporate bonds, and, as such, primary dealers’ inventories have fallen 76% since 2007.  We saw the effects of this during the last few weeks of June, as a sell-off in the overall bond market, coupled with mutual fund redemptions, caused heightened volatility.  This trend reversed throughout the first two weeks of July, as corporates outperformed, but it serves as an important reminder of how the financial crisis has changed the landscape across the system.  We have always maintained a policy of holding credits that carry high credit quality and liquidity; this served us well during June and we think will continue to do so in the future.